Frozen mortgage trusts
From time to time, our clients ask us for financial advice. Legally we can not offer such advice. However to assist clients in achieving a better understanding on this important issue, the following article has been written to help you. Any specific questions you have on mortgage trusts should be made direct to your qualified financial planner.
The sub-prime crisis is just one example of how, in a complex financial system, a tweak or a glitch at one point can have unforeseen consequences somewhere else. Another example is the decision by the Australian Government to offer a guarantee over all deposits with Australian banks. The ensuing flight to safety has caused problems for mortgage funds—which are not covered by the guarantee— and for their investors.
Why the freeze?
Mortgage trusts are caught up by the perennial problem of “borrowing short and lending long”. They offer investors access to their funds at relatively short notice, but they invest in mortgages with terms between five and twenty years.
Normally, this isn’t a problem. The trusts maintain a certain level of liquidity, for example 20% of the value of the fund, and along with the ability to balance applications for investment against the requests for redemptions, investors usually don’t have any difficulty in accessing their funds when required.
In the current climate, however, fear has driven many people to seek the security of the government guarantee on bank deposits. Many mortgage trusts have experienced a huge increase in the demand for redemptions, and once the cash component has been exhausted, the only way to fund these redemptions is by selling the underlying mortgages. With all mortgage funds selling into a depressed market the value of these mortgages would plummet, and that’s not good for investors.
In order to protect the interests of all investors, and to ensure the managers of the fund fulfil their obligation to treat all unit holders equally, mortgage trusts really had no choice but to either freeze or limit redemptions. For people in genuine need of those funds, this has created major problems.
Still low risk
The mortgage trusts offered by mainstream fund managers generally invest in first mortgages with a relatively low loan to valuation ratio. Many trusts only loan up to 60% of the value of the property, providing good prospects that they will recover their money in the rare cases where borrowers default on repayment. Risk is also lowered by investing in a wide range of mortgages. Unlike the sub-prime situation in America, the default rate on Australian mortgages is extremely low.
Hope yet
In response to the freezing of funds, the Australian Securities and Investment Commission (ASIC) has introduced relief provisions. Investors facing genuine hardship will be able to withdraw a portion of their investment. However, as the definition of “hardship” is quite restrictive, only a small number of investors are likely to be eligible. In addition, some mortgage trusts will allow periodic (e.g. quarterly) withdrawals, with the amount that each investor can access dependant upon the liquid funds available to the manager.
Both regulators and managers are seeking a quick resolution to this problem. Once stability returns to investment markets, mortgage trusts should be able to resume their normal redemption policies. In the meantime, if you are concerned about your investments with any mortgage trusts, consult your adviser.
Sources:
‘ASIC offers mortgage fund withdrawal relief’. Money Management, 3 November 2008 –
Mariner Securities: Mariner Mortgage Trust Change to Redemptions –
www.marinerfunds.com.au/data/MMTQA.pdf
Changes to Monthly Income and Mortgage Funds, Term Fund and WealthFocus options 11 November 2008 –
http://www.perpetual.com.au/advisers/fundchanges.htm